1. William Shakespeare in Romeo and Juliet wrote in the famous balcony scene “what is in the name? That which we call a rose by any other name would smell as sweet.” The said view is equally applicable when it comes to analyzing the GST implications on various payments made to the directors. The word “director” in our opinion cannot decide the implications under GST. We need to differentiate between an employee-director vis-à-vis a non-employee-director to decide the implications.
2. But before we do that we shall submit that the whole controversy in respect of whether the companies are liable to pay tax under RCM on payments made to directors has erupted recently due an Advance Ruling in the case of Clay Craft India Pvt. Ltd. (RAJ/AAR/2019-20/33). We shall come to the given ruling later but first we need to understand the law on the issue.
3. Now Notification No. 13/2017 – CT (R) dated 28.06.2017 issued by exercising the powers granted u/s 9(3) of the CGST Act, 2017 provides at Sr. No. 6 that the tax on the services supplied by a director of a company or a body corporate to the said company or the body corporate shall be paid by the company or a body corporate (i.e. under Reverse Charge Mechanism (RCM)). Similar notifications exist under SGST Act(s), 2017 as well as IGST Act, 2017. Therefore we need to first examine whether there are any services rendered by the director to the company for it to be covered within the ambit of RCM. In the absence of any service, there would be no liability.
4. The readers are aware that the GST is levied on the supply of goods/services. The scope of supply is contained u/s 7 of the CGST Act, 2017. Sec. 7(2)(a) of the said Act provides that the activities or transactions specified in Schedule III would not be treated as supply. In other words the transactions listed in Schedule III would not be liable to tax. Sr. No. 1 of the said Schedule III provides that the services by an employee to the employer in the course of or in relation to his employment shall not be considered as supply of services liable for tax. Therefore as stated earlier the name “director” is immaterial to decide the implications. What needs to be examined is whether a given person in question is an employee-director of the company or not.
5. The founding documents of any company are the Memorandum of Association (MOA) and the Articles of Association (AOA). AOA authorizes for the formation of the Board of Directors (BOD) by the initial subscribers of shares (shareholders) and later at the shareholder meetings. BOD is defined u/s 2(10) of the Companies Act, 2013 to mean the collective body of the directors of the company. The word “director” has been defined u/s 2(34) of the said Act to mean a director appointed to the Board of a company. Now the BOD is vested with all the powers which a company is authorized to do albeit with certain restrictions and limitations in accordance with Sec. 179 of the Companies Act, 2013. Therefore BOD can be said to be the governing body of the company vested with the responsibility of strategic oversight over business operations while directly measuring and rewarding management’s performance. Simultaneously the BOD has to ensure compliance with the legal framework, integrity of financial accounting and reporting systems and credibility in the eyes of the stakeholders through proper and timely disclosures. To enable the execution of the decisions the shareholders/BOD would appoint managing director, whole-time director or manager in accordance with Sec. 196 of the Companies Act, 2013.
6. Now different kinds of directors appointed to the BOD are in the nature of managing director (Sec. 2(54)), whole-time directors (Sec. 2(94)), independent directors (Sec. 2(47)), nominee director, etc. Certain of these directors (mainly managing director and whole-time directors) are further duly granted responsibilities and duties of execution by the BOD under its supervision and control to perform the work over above the performance of their responsibility as part of the BOD collective during the Board meetings. Consideration in the form of salaries, perquisites, commission, etc. as decided by the shareholders/BOD are paid to such directors in relation to the labor expended. However certain directors (mainly independent and nominee directors) are not granted any executive duties and responsibilities except for the attendance of the Board Meetings and to perform their role as part of the BOD. Therefore we need to now understand whether the directors performing executive functions entrusted by the shareholders/BOD over and above their role as part of the BOD can be considered as an employee of the company (i.e. employee-director) and hence the services rendered by such employee-directors would be outside the ambit of GST.
7. Landmark decisions to understand the test of employer-employee relationship is of the Hon’ble Supreme Court in the case of Ram Prasad CIT [1972] 86 ITR 192 (SC) and Employees State Insurance Corpn. v. Apex Engg. (P.) Ltd. [1998] 1 SCC 86 (SC). In the said cases the Hon’ble Court has held that to determine whether a person is an employee or not it has to be ascertained from the conditions of the employment. Following factors would be relevant:
a. The employer’s authority of selection of an employee
b. Payment of remuneration,
c. The employer’s right to control the method of doing the work and the right of suspension/dismissal. Generally it may be possible to say that the greater the amount of direct control over the person employed, the stronger the conclusion in favor of his being an employee. Similarly the greater the degree of independence the greater the possibility of the services rendered not as an employee.
8. Now let us apply the said factor test to various directors in question.
MANAGING DIRECTORS/WHOLE-TIME DIRECTORS (ALSO REFERRED TO AS EXECUTIVE DIRECTORS)
9. As discussed before the company through its BOD could select any person including a director to act as its employee and entrust the employee-specific executive role to be performed. Managing Director/Whole-time Directors are indeed entrusted specific roles akin to an employee. The remuneration of the said directors is also decided and controlled by the company as in the case of any other employee. The manner and the method to be adopted by such directors for discharging their functions are subject to the supervision and guidance of the BOD. The company also has complete discretion and freedom to terminate the services of any of the employees and it could divest any of such directors from the employee functions after which it would only remain as a director in the board and ceases to become a managing director/whole-time directors. They are also regarded as the officers of the company. Further none of the employees or such directors could claim any kind of protection or privileges qua the company. Therefore we submit that the managing director/whole-time directors applying the test laid down by the Apex Court would be the employees of the company and hence the services rendered by such directors would be outside the scope of GST.
10. The above contentions are further strengthened by the fact that the Income Tax TDS under the head salaries and PF as applicable to employees are deposited on the amounts paid to such employee-directors.
11. Reference can also be made to the definition of “employee” under the Unlisted Companies Equity Share Rules, 2003 which means a director of the company, employed as a whole-time director or executive director of the company.
12. Now one may contend that such persons perform a dual role on one hand of being an employee of the company for the executive roles and responsibilities entrusted by shareholders/BOD and on the other hand of being a director performing the role as part of the BOD collective. Generally no sitting fees are paid to such employee-directors for attending the Board meetings and discharging their role as part of the BOD. Also the attendance at the Board meeting is part of the obligations cast on such persons as part of the employment contract itself. Hence a view can be taken that as their role as an employee eclipses their role as a director and as the services performed by an employee “in the course of or in relation to the employment” is outside the ambit of GST by virtue of Sr. No. 1 of Schedule III even on this ground the remuneration paid to such employee-directors cannot be subjected to tax.
INDEPENDENT DIRECTOR/NOMINEE DIRECTOR (NON-EXECUTIVE DIRECTORS)
13. Although the said directors are also appointed by the shareholders/BOD based on the provisions of law as well as various covenants and thereby are under the overall supervision of the BOD would not make them the employees of the company by adopting the factor test discussed above. This is because they do not undertake executive roles or responsibilities except the responsibility of a director simpliciter by way of attending the Board meetings and getting paid by way of sitting fees. Thus sitting fees paid to such non-executive directors would be liable to tax under RCM.
14. Lastly let us see the judgment of the AAR (Clay Craft India Pvt. Ltd.) which has caused the present debate. In the said decision it is astonishing to find that no reasoning has been given by the authority as to how the directors in question would not be considered as an employee of the company. Further the applicant has submitted that the company was paying the GST under RCM on the commission paid to the directors on the ground that the said commission is paid in the capacity of a Director and not in the capacity of an employee but was not paying the GST on the salaries. We submit that the said decision is not a good law as it has not considered the legal contentions discussed above. Also the said decision can be clearly distinguished from the general facts prevailing in the industry wherein the commission paid to employee-directors with respect to the executive roles and responsibilities is considered as part of the salaries only. Needless to say the said decision would also not bind any other taxpayers.
15. Hence to conclude we submit that the services of an employee-director would not be subjected to GST. Evidence in terms of the AOA, Board resolution, employment contract (having terms of employment in the nature of duties to be performed, remuneration, repercussions on non-performance, etc.), TDS under Income Tax, PF, etc. as discussed above should be maintained to prove the true nature of the relationship. On the other hand sitting fees paid to non-employee directors would be liable for GST which should be paid by the company under RCM.
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